Tuesday, December 29, 2009

Gold Price Manipulation?

Here's something I wrote about 10 months ago that is relevant to my last post. I dug up information in relation to the question of "is the price of gold being manipulated?" While I don't claim to have a good answer to my speculation about gold swap/trades being a possible mechanism for price suppression (I've had a half-dozen people respond, about 50-50 pro-con), this data at least appears to support the assertion that demand is way up relative to supply:

Note that the table shows that gold bar hoarding is only 9% of total demand. True or not, that would greatly diminish the upward price pressure on gold from panicked investors. On the other hand, note that I don't have figures for Q4 2008 or Q1 2009 -- the panic has surely accelerated since the election and the "stimulus bill" (even among supporters of that bill).

If you grant that gold production is declining, the link says:

"The biggest contributor to the increase in total identifiable demand in Q3 was identifiable investment, up 137.5 tonnes (56%) relative to year-earlier levels. Jewellery demand rose 45.5 tonnes or 8%, while industrial and dental demand declined 11%."

In other words, even after significant declines in industrial consumption of gold, demand is way up. Interestingly, you'll note that they say "bar hoarding" is only about 9% of total demand -- but up 69% from a year ago. What *isn't* given is coin hoarding. Right now, all accounts suggest that something approaching 100% of coins are being hoarded... and coin minting is up 60%.

" With financial markets still reeling from the global credit squeeze amid growing inflationary pressures, dollar demand for gold reached US $20.9bn in the first quarter of 2008, a 20% increase over the same period in 2007 and more than double the level of four years earlier. However, tonnage demand for gold at 701 tonnes was down 16% on the same period last year and represents the lowest quarterly figure for five years, according to Gold Demand Trends, which is released today by World Gold Council (WGC)."

This is from May 2008, but I still find it absolutely bizarre, if I even understand what they are saying. Jewellry accounts for about 60% of world gold demand, and they say

"Jewellery demand declined 21% year-on-year to 445.4 tonnes, the lowest quarterly level since the early 1990s"?

Perhaps it's the general economic decline. They do say (again, this was May 2008),

"Industrial and dental demand declined by 5% on year earlier levels to 110.3 tonnes, primarily in response to the deteriorating US economy, and a slowing in demand for consumer electronics."

From the charts below, industrial and dental demand for gold is about 20% of world demand, so a 5% drop represents about a 1% drop in overall world gold demand, year on year.

They also say

"The supply of gold was 6% higher in Q1 2008 than a year earlier, primarily driven by increased scrap supply which in turn was a reaction to the rising gold price. Mine output remained constrained, little changed from Q1 2007 levels at 593 tonnes, while net official sector (central banks) sales were 8% higher than in Q1 2007."

These guys are a little more optimistic about gold production than other reports, which suggest an actual decline in mine production. But again -- this report was May, 2008.

Here's a possible partial explanation for the price of gold not skyrocketing: Maybe it's already priced out for today's events. From this link:

"While it has already come far from its humble beginnings in the $250s in April 2001, [gold's price] has a long way to run yet."

In other words, gold is 4 times more expensive today than 8 years ago. Now, one of the most interesting (and significant) things about price mechanisms is that they anticipate events. Let me hypothesize, then, and ask: did smart investors start anticipating world events from 2001 forward to bid the price of gold up? In other words, is the explanation for the lack in more dramatic upward movement in the price of gold today simply because the price of gold has already anticipated today's events?

I think that is part of the explanation, though not all of it. The same applies to stocks when a glowing earnings report causes a decline in the stock price, simply because the earnings half a point below expectations -- the stock declined because it was priced at the market's expectation of all future earnings, and when the most recent earnings report comes in a little lower than that projection, the cumulative future earnings decline in the new projection, so the value of the company declines. (That is, I'm arguing on the basis of my theory that the value of a company is the sum of all future net earnings, discounted for risk, uncertainty, and the time value of money.)

But anticipated gold price projections can't be the full explanation for the relatively stable price of gold today. The dramatic increase in demand today should still be driving prices up at a faster rate than they are, I think. I go back to my comment that a 5% increase in the demand/supply ratio of oil can double the price of oil.

So the question here remains to be proved: is the rate of increase in the price of gold in line with the increased demand, or is there government manipulation holding the rate lower?

Look at the price over the last 34 years, unadjusted for inflation:

You might not think the price of gold is being suppressed, but now here it is adjusted for inflation:

Wait till the coming increase in inflation (maybe hyper) steps in about 12 - 24 months from now. That curve will rocket upward.

"...global gold production is actually falling despite the relatively high gold prices. Annual gold mined today, which is 70% of the world’s supply, is running over 4% lower than when this bull began in 2001! "

They provide a chart in another link (http://www.zealllc.com/2008/goldprod2.htm):

When you consider that the economy is far worse today that it was in 1980, and the panic among investors is unequaled since 1929, and gold production is declining as well, you simply have to suspect Something is Rotten in Denmark.

"In mid-December a reader forwarded me a timely article exposing the plight of Swiss gold refiners and their ‘difficulty in keeping up with demand for gold bullion leading to long delivery times as investors were becoming wary of other stores of wealth.’ ...'I have been in the gold business for 30 years and I have never experienced anything like this,” said Bernhard Schnellmann, director for precious metal services at Argor-Heraeus, one of the world’s three largest refineries. He went on to say, “Even though production has increased dramatically since the middle of the year…..we simply cannot cope with the demand.' ...In the case of coins, the delivery date has gone from a couple of days at the beginning of the year, to six to eight weeks! And remember, the Swiss refineries are working day and night, seven days a week. ...Something has to give - especially when global production is estimated at approximately 2,500 tonnes annually…and global demand is closer to 4,000 tonnes. And those are 2007 figures and do not take into consideration the dramatic rush to bullion."

I've heard and read of numerous reports of long delivery times, which are consonant with a much higher price of gold than we are seeing -- certainly much higher than $950/oz in today's world.

Let's take the premise that Q3 numbers, being before the election and before the meltdown, are grossly understated. I'm going to arbitrarily put the present Q1 2009 non-industrial bullion and coin demand at 100% higher than than Q1 2008 (bar hoarding / coins from table at top): 400 tonnes. I suspect this considerably understates the actual private demand at this moment in time. This represents an increase in world wide demand of 200 tonnes, year-on-year. Out of a total demand of 1133 tonnes, that's a 17.6% increase in the supply/demand ratio.

If you take a cue from the oil market, and say that each 5% increase in supply/demand doubles the price, I'd expect that 17.6% increase to be reflected in a 2^(17.6/5) = 11.5: increase in price -- say, $10,000/oz.

NOTE that I don't include national gold reserves in this calculation -- they are "out of the market" and don't represent a supply on the market, per se, except to the extent governments choose to throw them in. It's a government-run cartel, not unlike the diamond cartel which keeps diamond prices higher than they would otherwise be.

But let's see what total national reserves of gold are. From Wikipedia: "11,065 tonnes as of December 2007" (http://en.wikipedia.org/wiki/Official_gold_reserves). So the current private demand of 400 tons (I speculate from extrapolation) is a miniscule fraction of national reserves:

I abridged the full table. But what you can see is that the U.S. reserves (73.5% of the world) are by far the largest, and an increase in private demand of 200 tons for Q1 2009 (as I speculate) can easily be handled by the Treasury simpling selling bullion onto the market. They aren't going to run out. Of course, to keep it up for an entire year would take 800 tons -- not chump change.

It appears that at present I don't have to go to more exotic gold-swap theories to explain how central governments can suppress the price of gold, and the day to revisit that discussion may yet be coming, but about then governments will begin nationalizing gold. So ... buy small quantities to avoid reporting requirements, and find a secure hiding place. (NOT a safe deposit box.)

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